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Paying a Premium for Climate Resilience

Experts are asking whether insurance would be a good way to protect poor farmers against the more frequent droughts and floods that climate change brings. Photo credit: Flickr/CIMMYT

What is the best way to protect vulnerable rural communities from the damaging impacts of climate change? Insurance could be an answer, but it raises a number of difficult questions.

To illustrate, the New York Times recently ran a story, “Report Says a Crop Subsidy Cap Could Save Millions.” The piece discusses a new U.S. Government Accountability Office (GAO) report that investigated the costs and distributive effects of the federal insurance program that protects farmers against crop failure and low market prices. This is a costly program for the federal government – farmers pay only 38 percent of the premiums, and the rest is covered by federal subsidies. Payouts are skewed toward the largest farms, which may receive very large payments because there is no subsidy cap. The cost to U.S. taxpayers in 2011 was $7.3 billion.
Would farmers have purchased insurance that was not subsidized? Do subsidies encourage reckless risk-taking and distort land markets? What are the economic impacts of limitless payouts to large farms?

The same kinds of questions are now being raised in the very different context of the poorest and most vulnerable rural communities in Ethiopia, India, Mexico, and other countries. Climate policy experts are asking whether insurance would be a good way to protect poor farmers against the more frequent droughts and floods that climate change brings. If so, could the Green Climate Fund, now in its design phase, include an insurance component?

To inform climate negotiators, policymakers, and development practitioners, the World Bank’s Social Resilience Cluster is embarking on a major evaluation of what is known about insurance in poor, rural communities. Their effort focuses on so-called index-based insurance initiatives, where payouts are made not on the basis of actual crop loss on individual plots of land – which is labor-intensive and time-consuming to assess – but on the objective measurement of rainfall deviations from the norm, which correlates closely with crop and livestock loss. Although design costs are higher, managing an index-based insurance scheme is cheaper, and payouts to farmers can be done much faster than when actual losses must be determined.

The questions asked above about U.S. farmers become more profound for rural people who live near their margins. Can index insurance be scaled up and sustained to really cover the poor in the long term, so that it transforms livelihoods into a state of greater resilience? And if so, is insurance good value for money – for households, governments, and donors – compared with other means of managing risk, including social protection schemes or emergency relief after extreme weather events?

As for answers, on many of them the jury still seems to be out. At a recent retreat sponsored by the Rockefeller Foundation (in which WRI took part), a group of researchers, policymakers, and development practitioners reviewed what the World Bank’s analysis has produced so far. Through assessment of dozens of smaller-scale and pilot projects, as well as a few larger ones, a fundamental problem was identified: Insurance actuaries need long-time series and large samples in order to determine the probabilities of extreme events to set premium prices. Most of the project data now available do not allow those parameters to be determined, making projections about future costs very uncertain.

Also, in almost all index insurance projects, premiums have been subsidized by government or donors. The same question being asked about U.S. farmers is therefore also relevant for their less fortunate colleagues in developing countries: Would they pick up the full premium costs without subsidies? Early indications are that they would not. Consequently, there is little evidence so far that index insurance by itself will have a transformative impact on poor households. It may even be the other way around: that the farmers who have access to financial services, agricultural inputs, technology, and markets—and who are already on safer ground—are the ones who will be able to use insurance as a way to lower the risk of investing in potentially more high-yield but also more demanding crops.

But work on answering these questions continues. Available data is being further analyzed, and a number of field studies are underway that will complement what we know now. Index insurance may be judged to have an important place among the instruments that will underpin increased agricultural productivity and food security in a changing climate, albeit within limits. One thing is certain: Much more research and development is needed to find the most effective ways of protecting the poorest and most vulnerable from the impacts of a changing climate. One question leads to the next.